John wiley sons theplete guide to buying and selling apartment buildings (2005) ocr 7 0 2 6 lotb

THE COMPLETE GUIDE TO BUYING
AND SELLING APARTMENT
BUILDINGS



The Complete Guide
to Buying and Selling
Apartment Buildings
Second Edition

STEVE BERGES

John Wiley & Sons, Inc.


Copyright © 2005 by Steve Berges. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or
by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted
under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission
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Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201)
748-6008.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in
preparing this book, they make no representations or warranties with respect to the accuracy or completeness
of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a

particular purpose. No warranty may be created or extended by sales representatives or written sales materials.
The advice and strategies contained herein may not be suitable for your situation. The publisher is not engaged
in rendering professional services, and you should consult a professional where appropriate. Neither the
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limited to special, incidental, consequential, or other damages.
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Library of Congress Cataloging-in-Publication Data:
Berges, Steve, 1959–
The complete guide to buying and selling apartment buildings / Steve Berges.
p.
cm.
Includes index.
ISBN 0-471-68405-8 (pbk.)
1. Apartment houses—United States. 2. Real estate investment—United States. 3. Apartmetn houses—
Purchasing—United States. 4. Residential real estate—Purchasing—United States. I. Title: Guide to buying
and selling apartment buildings. II. Title: Buying and selling apartment buildings. III. Title.
HD259.B47 2004
333.33'8—dc22
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1

2004042246


D E D I C A T I O N

It has been said that behind every good man is a good woman. This statement holds true for me, except that in my case, there have been two good
women. This book is dedicated to the two women who have had a most
profound influence on my life. They are my mother, Eleanor May Miller
Berges, and my wife, Nancy Anne Thompson Berges.
In memory of my mother, thank you for your kind words of encouragement throughout my childhood years. I will always remember your example of dedication and perseverance to attain your goals. It was you who
convinced me of my self-worth, and it was you who taught me to believe
in myself. Your example will forever live in my heart.
To my beloved wife, thank you for your continued support over the years.
While my mother laid down the torch of life, you have picked it up in her
stead. You are now the driving force in my life. It is you who carries on
her tradition of love, confidence, and inspiration. It is you who gives me
strength when I need it most. Of all the things God created, truly you are
the most beautiful.

v



A C K N O W L E D G M E N T

I wish to express my sincere thanks to my wife, Nancy, for her editorial
support during the production of this manuscript. Her wisdom and
insight have contributed significantly to the successful completion of this
book.

vii



C O N T E N T S

CHAPTER 1

Introduction to Multifamily Ownership
Introduction
Holistic Approach
Background
Market Outlook
Regional Trends

CHAPTER 2

Advantages of Multifamily Ownership
Time and Efficiency
Market Liquidity
Transaction Costs
Concentration of Units
Management and Labor Considerations
Tax and Record Keeping Considerations
Divestiture of Property

13
14
15
16
17
17
18
18

CHAPTER 3

Bridging the Gap
Strategies
Leverage—The OPM Principle
Clearly Defined Objectives
Maslow’s Hierarchy of Needs
Conquering Your Fears

21
22
23
24
27
29

CHAPTER 4

The Value-Play Strategy
Buy and Hold versus Buy and Sell
Ten Ways to Create Value
Diamonds in the Rough
How to Tell a Diamond from a Lump of Coal

35
36
39
47
61

CHAPTER 5

Establishing Your Niche and Locating Properties
Establishing Your Niche
Availability of Resources
Property Size
Property Age
Holding Period

69
70
70
71
74
79

ix

1
1
2
4
6
9


Contents
CHAPTER 6

Six Ways to Locate Properties

Real Estate Brokers
Classified Advertisements
Industry-Specific Real Estate Publications
Local and National Web Sites
Associations and Real Estate Investment Clubs
Banks

CHAPTER 7

Financial Analysis
Valuation—How Much is That Property Really Worth?
Two Crucial Principles That Saved Me $345,000
Valuation Methodologies
Financial Statements
Five Key Ratios You Must Know
The One-Minute Assessment
How to Read Between the Lines

91
92
93
95
102
117
124
125

CHAPTER 8

Case Study Analysis

Case Study 1: 52 Units in Flint—My Way or the Highway
Case Study 2: 12 Units in Saginaw—Below-Market Rents
Case Study 3: 16 Units in Beaumont—A Banker’s REO
Case Study 4: 98 Units in Houston—Creating Synergism
through Consolidation

129
129
142
151
162

CHAPTER 9

Negotiation Strategies and the Due Diligence Process
Five Cardinal Rules of Successful Negotiation
The Due Diligence Process

175
176
185

CHAPTER 10

Financing Your Acquisition
Traditional Financing Alternatives
Secondary Financing Alternatives
Additional Financing Considerations

191

192
203
206

CHAPTER 11

Closing the Deal
Closing Fundamentals
Closing Credits Can Add Up

215
216
219

CHAPTER 12

Managing Your Property
Hiring a Professional Property Management Firm
Your Role as a Strategic Manager
Expect the Unexpected

223
224
227
228

x

85
86

87
88
88
89
89


Contents
CHAPTER 13

Four Effective Exit Strategies
Outright Sale
Refinancing
Equity Partnership
Exchange of Properties
Combining Methods

233
234
235
245
248
249

CHAPTER 14

Five Keys to Your Success
Understanding Risk
Overcoming Fear of Failure
Accepting Responsibility

Willingness to Persevere
Defining Your Sense of Purpose

255
256
259
261
264
267

APPENDIX A: WWW.THEVALUEPLAY.COM

273

APPENDIX B: WWW.SYMPHONY-HOMES.COM

275

GLOSSARY

277

INDEX

297

xi

THE COMPLETE GUIDE TO BUYING
AND SELLING APARTMENT
BUILDINGS



C H A P T E R

1

The Light of Integrity
The soul is dyed the color of its thoughts. Think only on those things that are
in line with your principles and can bear the full light of day. The content of
your character is your choice. Day by day, what you choose, what you think,
and what you do is who you become. Your integrity is your destiny . . .
it is the light that guides your way.
—HERACLITUS

Introduction to Multifamily
Ownership

Introduction
The systematic acquisition of real estate properties over time is unquestionably one of the surest means of accumulating wealth. While building a
respectable real estate portfolio is a process that can take months, or even
years, the patient and diligent investor enjoys a high probability of earning
above-average returns for his or her efforts. Careful analysis, however, is
required for each and every property considered. Proper analysis is not limited to a simple review of the property’s condition and location. To be successful in this business requires a more exhaustive approach.
This book is intended as a guide to developing a format for a thorough
examination of each and every property you are considering. This format,
when properly applied, will provide you with a significant competitive edge.

It is my intent that by following the guidelines in this book, you will no
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THE COMPLETE GUIDE TO BUYING AND SELLING APARTMENT BUILDINGS

longer arbitrarily determine value as it applies to real estate; rather, you will
truly understand it. By the time you are finished reading this book, you will
know why a multifamily complex, for example, is worth only $700,000 instead of the $950,000 the seller is asking. Proper understanding of this single principle can be the difference between success and failure.
While readers of this book are likely to have broad and diverse backgrounds,
you do share one thing in common—your interest in real estate. I will
attempt to be as thorough as possible, because some readers are likely to
have little to no experience, while others are seasoned professionals searching for that edge. This being the case, those readers who have a great deal of
experience may find some of the material to be a bit basic. It is crucial, however, to lay the proper foundation for those who are not as experienced.
Many readers have most likely purchased single-family houses at one time
or another and have at least a minimal degree of rental property experience.

Holistic Approach
In addition to providing a comprehensive approach to analyzing, buying,
and selling apartments, this book also offers a holistic approach that will
enable you to more fully achieve your true potential. Personal examples,
inspiring stories, anecdotes, and quotes are used throughout to stir your
mental faculties and encourage you to reach deep within yourself to fulfill
your dreams, whatever they may be. While understanding the mechanics of
multifamily transactions plays an important role in the level of your success,
it is my personal belief that the stories and examples used throughout the
book are what will truly enable you to become successful, not only in real
estate, but in life as well.
I cannot help but feel that the hand of Providence guides my writing from
time to time, as thoughts flow freely from my heart and mind with little or

2


Introduction to Multifamily Ownership

no effort. After the first edition of this book was published, I received overwhelmingly positive responses from readers who were inspired for one reason or another by portions of it. For example, one kind lady named Melinda
was so inspired, she felt compelled to contact me, which she did only a
month ago. Melinda, who is from New York, had just suffered the loss of her
husband a few short weeks before. I listened to Melinda’s story for well over
an hour with empathy as she described how despondent she had felt after
her husband died. Not sure where to turn, she happened across my book
and after reading it thoroughly, felt a renewed sense of hope, knowing that
somehow everything would be all right. Melinda’s kind words of gratitude
left me feeling appreciative that in some small way, I had been instrumental
in lifting her spirit, even if only for a moment.
Recently, I received a call from a gracious gentleman named Lambis who
lives in Athens, Greece. Like Melinda, he, too, had just finished reading this
book and felt compelled to contact me. Lambis explained how he had been
in one of the largest bookstores in Athens searching for a book on real estate
investing. When he asked one of the employees where the real estate section
was, he was told the bookstore did not have one. Lambis explained to me
this was due to the fact that there really is no real estate market in Athens
because families rarely move. In other words, once a family purchases a
house, they stay there for most of their lives and often pass the house down
from one generation to the next. As Lambis was perusing the economics
section of the bookstore, however, he came across a single real estate book,
which just happened to be this one.
Lambis then proceeded to tell me that he would be flying to the States in two
weeks and would like to meet with me. Feeling honored at such a request, I
readily agreed. While Lambis arranged his flight schedule, I arranged my work

schedule to set aside an entire day for him. In fact, it was just last Friday that
the two of us met. Lambis, a most remarkable man, shared many fascinating
stories with me over the course of the day. He told me of his grandfather, a
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THE COMPLETE GUIDE TO BUYING AND SELLING APARTMENT BUILDINGS

prominent engineer, well-known for his numerous contributions to major
projects throughout the city of Athens. He told me of his father, another distinguished engineer, who built one of the most respected companies in Athens
employing over 4,000 men and women. He also told me of the devastating
setbacks his father experienced due to the oil embargo during the late 1970s.
Lambis explained that although his father had built a vast empire, there was
one primary flaw that contributed to the ultimate demise of the family’s business. His father’s management style was extreme control in every facet of the
organization. It was this unwillingness to relinquish control and delegate
responsibility to his senior managers that set the stage for the inevitable collapse of the business. When the oil crisis occurred, it was as if one leg, and
then another, was knocked out from underneath a three-legged stool. When
one leg is removed, the stool becomes very unstable, and when the second leg
is removed, the stool has no choice but to fall. Rather than declaring bankruptcy, Lambis’ father spent the next decade liquidating the company’s
assets in an effort to repay as many of the debts as possible. During that
period, his father, once a Greek icon of monumental stature, suffered a series
of no less than 10 heart attacks. He passed away in 1991 with his majestic
honor, his noble character, and his impeccable integrity fully intact. Saddened by this tragic loss, Lambis vowed not to repeat his father’s mistakes in
his own business affairs. It was apparent to me that he had indeed learned
from his father, as Lambis is today a successful businessman in his own right,
with a management team in place that allows him to freely come and go without the day-to-day oversight required by most business owners.

Background
A confluence of events from my own life experiences over the past 20-plus
years has provided me with unique insights on the real estate market. Three

primary components have contributed to my experience.
4


Introduction to Multifamily Ownership

First and foremost, like many of you, I have bought and sold a number of
both single-family and multifamily properties over the years. As principal of
Symphony Homes (www.symphony-homes.com), a residential construction
company, I am a current and active investor.
Second, my experience as a financial analyst at one of the largest banks in
Texas has provided me with a comprehensive understanding of cash-flow
analysis. Working in the bank’s mergers and acquisitions group, I reviewed
virtually every line item of the financial statements of related income and
expenses for numerous banks that were potential acquisition candidates. I
spent 8 to 10 hours a day using a fairly complex and sophisticated model to
determine the proper value of these banks, given a specific set of assumptions. Since leaving the bank some years ago, I have developed my own proprietary model, which I now use to assist me in determining the value of
multifamily properties. The beauty of understanding cash-flow analysis is
that once you grasp the concept, it can be applied to anything that generates
some type of cash flow, whether it be banks, apartment complexes, manufacturing businesses, or fast-food restaurants.
Finally, my experience as a commercial mortgage broker has provided me
with an inside look at the lending process—more specifically, what the
lenders’ underwriting departments typically look for. This book devotes an
entire chapter to this subject, and I am confident that it will enable you to
present a property in its most favorable light when you are seeking funding.
Although I had bought and sold real estate for a number of years prior to my
experience at the bank in Texas, it was after I gained a more complete
understanding of the principles of finance learned during my graduate studies at Rice University and my tenure at the bank that I was able to significantly accelerate my investment goals. I developed my own proprietary
financial models that enabled me to more fully analyze an asset’s value based
on its cash flows and price relationship to similar assets. The combination of

5


THE COMPLETE GUIDE TO BUYING AND SELLING APARTMENT BUILDINGS

these financial analysis tools and a sound understanding of valuation principles has allowed me to increase my personal real estate investment activities
from a meager $25,000 in volume a year to a projected $8 to $10 million
this year alone. I am confident that the culmination of my own skill sets and
life experiences will be of great benefit to you as you seek to enlarge and
develop your own real estate holdings.

Market Outlook
With interest rates at 40-year record lows, more people than ever are enjoying the benefits of home ownership. On the surface, this would seem to have
a negative impact on the apartment industry. After all, if a greater number
of families are purchasing homes, then surely there must be a fewer number
of families who are renting houses and apartments, right? The answer is,
not necessarily. In fact, research conducted by several leading analysts of the
multifamily industry suggests the market outlook for apartments is actually
quite favorable for several reasons. According to a report by the chief economist of the National Multi Housing Council, Mark Obrinsky, changes in
population, demographics, and household composition will each have a
positive impact on the apartment industry (January 29, 2004 issue). Obrinsky supports his assertions in the following excerpt.
When John F. Kennedy famously said “a rising tide lifts all boats,” he wasn’t
talking about the apartment industry. He wasn’t even talking about housing.
Yet, his sentiments apply very nicely to our industry today. Conventional wisdom tells us that low interest rates and government incentives are driving
home ownership rates up, and that those increases are bad news for apartments. Not so, according to NMHC analysis. The rising tide in this case is our
country’s rising population, which will raise demand for both owner- and
renter-occupied housing. Housing, in other words, is not a zero-sum game,

6

Introduction to Multifamily Ownership

and home ownership’s gains are not the apartment sector’s losses thanks to
demographics, immigration and population gain.
While banking changes and the investment climate drove home ownership
rates up in the 1990s, the key factor driving housing demand in the next
decade is demographics. Population growth—through natural population
increase, continued high levels of immigration, and increased life spans—will
increase demand for owner- and renter-occupied housing.
And some demographic trends will clearly favor rental housing, especially
the swell of echo boomers and the continuing shift toward single-person
households. After declining for two decades, the population in the traditional
renting years (ages 20–29) is expected to increase 11 percent between now
and 2010. Eventually more than 80 million “echo boomers” (ages 8–27) will
move into the housing market, most likely as renters first. And there is no
“baby bust” expected behind this generation, just a plateau.
Then there are the changes in household composition underway. The
households most likely to own—married couples with children—are declining
in number and now account for less than one-quarter of all households.
Meanwhile, two-thirds of all new households in the past decade were nonfamily households, which have the lowest home ownership rates. This demographic shift alone would cause the overall home ownership rate to drop by 70
basis points by 2010.
Immigration will create even more new renters. Over two million legal
immigrants have entered the U.S. since the beginning of this decade. In fact,
fully 50 percent of the expected population growth in the U.S. will be immigrants, and half of all immigrants are renters.

Data taken from the United States Census Bureau also suggests that
increases in the population are all but certain. Based on current growth projections, the population is expected to increase from its current level of 285
million people to a level of 315 million by 2010. This represents a phenomenal increase of 30 million residents over the next few years. The increase in
growth will necessitate an increase in demand for housing, which is likely to

7


THE COMPLETE GUIDE TO BUYING AND SELLING APARTMENT BUILDINGS

place upward pressure on prices since the supply and demand ratio already
remains fairly tight. Furthermore, with increasingly strict environmental and
governmental regulations and concern over so-called “urban sprawl,” supply will become increasingly constrained as builders find it more and more
difficult to construct new housing. This, too, will place upward pressure on
prices for housing.
Obrinsky also makes a convincing argument that addresses the issue of low
interest rates. Although a low-interest-rate environment will initially have a
negative impact on the rental market due to a shift of renters opting to
become homeowners, this shift will eventually taper off as home prices
increase, thereby making them less affordable, and as rental prices soften,
thereby making them more affordable. Evidence of the balance between
home ownership and the rental market moving into equilibrium is already
apparent as new home sales have begun to moderate while rental occupancy
rates are strengthening. In the following excerpt, Obrinsky contends:
What if interest rates remain low? Won’t that draw renters out of apartments?
Our research mirrors the findings of a study by two professors at the University of California: interest rates play no discernible role in increasing home
ownership rates in the short- or long-run. Housing affordability can worsen
even with low interest rates if house prices are appreciating faster than household income, a situation that describes many current markets.
Many analysts believe the pressure on apartments from home ownership is
moderating. As rising house prices make them less affordable, renting
becomes a more competitive option. According to the Harvard University’s
2003 State of the Nation’s Housing report, if the recent run up in housing
prices makes home ownership too expensive, the number of new renters
expected in the next decade could easily grow from one million to five or six

million.
Interest rate changes and home ownership incentives aside, housing is not
the win-lose game many analysts would have you believe it is. The rising tide

8


Introduction to Multifamily Ownership

created by population growth and demographic changes will lift all boats—
regardless of whether they are docked at a single-family or a multifamily residence.
In the meantime, apartment firms are successfully competing with singlefamily houses by offering better locations, larger apartments, more userfriendly floor plans, cutting edge technologies, new amenities and abundant
conveniences. The multifamily sector will continue down the path of offering
not just a housing alternative, but a lifestyle alternative that many young professionals and empty nesters find attractive.

So there you have it. Obrinsky makes a convincing case for the apartment
industry over the coming decade. The culmination of an increase in population of over 30 million residents, changes in demographic trends and household composition, a tight supply and demand ratio, and equilibrium
between affordability of home ownership and the rental market all contribute to the positive outlook for multifamily property owners.

Regional Trends
In order to maximize the return on invested capital, investors also should be
aware of regional trends. On a national level, as Obrinsky claims, the rising
tide will lift all boats. Not all boats will be lifted as high, however, since the
gravitational pull of some regions is much stronger than that of others. For
example, coastal regions in the West, South, and East are all experiencing
positive growth for various reasons, while parts of the Midwest and the
Northeast are actually experiencing negative growth.
According to the 2004 “National Apartment Research Report” published by
Marcus & Millichap, changes in job growth combined with changes in the
new construction of multifamily apartments will directly impact the perfor-

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THE COMPLETE GUIDE TO BUYING AND SELLING APARTMENT BUILDINGS

mance of each market. Marcus & Millichap monitor and analyze different
markets throughout the United States and have devised a measurement
guide known as the National Apartment Index (NAI). Research analysts
assert the following in the report.
The NAI is a snapshot analysis that ranks 40 apartment markets based on a
series of 12-month forward-looking supply and demand indicators. Markets
are ranked based on their cumulative weighted-average scores for various
indicators, including forecasted employment growth, vacancy, construction,
housing affordability and rent growth. Taking into account both the forecasted
level and the degree of change over the forecast period, the index is designed
to indicate the relative supply and demand conditions at the market level.

Investors with limited capital interested in purchasing multifamily properties
may find it more difficult to participate in regional opportunities than
investors with a larger capital base due primarily to management requirements. A smaller 12-unit apartment building, for example, is likely to be
managed out of necessity by an owner who lives within a close proximity to
the property. Owners of smaller properties typically take more of a handson approach and are much more involved in the day-to-day operations of
running an apartment than owners of larger apartments. Larger multifamily
properties, such as those with 100 units or more, are typically operated by a
full-time manager with additional oversight provided by a management
company. An investor living in New York, for instance, can easily own and
operate a 250-unit apartment building in Florida since he or she is not likely
to be involved in the day-to-day operations of running it. On the other hand,
an investor living in New York would likely find it difficult to own and operate a fourplex located in Florida, unless responsibility for its management

had been turned over to a reputable property management firm.
Research conducted by Marcus & Millichap as reported in the 2004 NAI
highlights important changes occurring in the top 40 regional markets.
10